A think tank has urged the UK government to forgo onerous regulation of banking – which it says will create more problems anyway – and instead support the idea of low-risk “trust banks”.

The “trust banks” would be those whose customers’ deposits would be guaranteed with taxpayer support and they would not be permitted to grow into a “too big to fail” status, according to the Adam Smith Institute, based in London.

The trust bank idea would add to the range of banks on offer, at a time of limited competition when the industry is dominated by four or five big groups, Eammon Butler, director at the ASI, told this publication.

In criticising public policy on bank regulation, Dr Butler said: "We are trying to put Rolls Royce regulation on banks when people would rather have a Mini."

The ASI’s ideas come at a time when the government is expected to embrace the idea of “ring-fencing” the deposit-taking arms of banks from the investment banking segments, insisting on higher capital protections in the retail side. The idea, part of measures to avoid a repeat of bank runs such as affected Northern Rock, was presented in the autumn by the government-created Independent Commission on Banking. Policymakers are also working on the idea of creating “living wills” for banks under which a troubled institution can be wound up in an orderly way.

While wealth management is not explicitly referred to by the ASI report or by the Commission’s own proposals, any regulation of how banks operate and their capital strength is an issue for the industry, as some high net worth clients have suffered losses in the 2008 crash.

The ICB’s ring-fencing idea is based on the mistaken idea, the ASI says, that investment banking is inherently riskier than retail banking. The ASI points out that some of the most significant failures were at retail-only institutions, such as Northern Rock, HBOS and Bradford & Bingley, the mortgage lender.

The Adam Smith report, Getting the Policy Right, was written by former business professor Tim Ambler and City analyst Miles Saltiel.

The report also criticises the government’s other main proposal, forcing the banks to have more capital, which it says will leave the banks with even less money available to lend to small businesses, which are the engine of UK employment and growth.